Abhey Lamba and Parthiv Varadarajan

We are downgrading Apple to Neutral from Buy while adjusting our PT to $150 from $160. The stock has meaningfully outperformed on a YTD basis and we believe enthusiasm around the upcoming product cycle is fully captured at current levels, with limited upside to estimates from here on out. Our sensitivity work indicates bull case EPS of around $11 which, along with a cycle-peak multiple, indicates limited upside to the stock. Our LTVC work suggests more muted gains as well. As such, we move to the sidelines despite our expectations of a strong iPhone 8 cycle.

Key Points

Still expect strong iPhone 8 cycle. We concur that the upcoming product cycle is likely to drive a strong holiday season following into early next year; however, we believe strength is anticipated and see very limited upside to estimates from here. A few things make us cautious on consensus FY18 numbers: 1) potential pull-in of demand creating tough comps in the following year; 2) growth driven primarily by replacements vs. net new customers, limiting expansion of installed base; 3) initial supply constraints due to complexities around product ramp; 4) potentially higher ASPs for high-end SKU driving demand elasticity; 5) risk to out-year gross margins.

Sensitivity analysis and supply chain checks indicate limited upside to FY18. Current consensus for iPhone shipments, iPhone ASP, consolidated margins and EPS are at 242mm (up 12% Y/Y), $680 (up 3%), ~27% and $10.43, respectively. We think consensus expectations for FY18 do not leave much room for upside, rather, based on our current checks, we see potential downside risk to current forecasts. Our most bullish case yields earnings of about $11 for FY18, which is only ~$0.50 above consensus.

Other areas' contribution unlikely to drive significant growth uptick. China is likely to remain weak in the n-t. We find that recent developments in India are a step in the right direction; however, affordability continues to be constrained limiting n-t contribution from the country. On services, while we acknowledge the company's intent to double the line-item by 2020, we believe ongoing penetration of developing countries (where attach is lower) could weigh on meaningful expansion from current levels. Additionally, consensus is expecting 30% growth in services revenue/user over the next 2 years, which seems high.

Downgrading to Neutral from Buy; adjusting PT to $150 from $160. At 15x and 11x NTM EPS and FCF, the stock is trading near the upper-end of its recent valuation range and we believe it is tough to expect the multiple to expand. With limited upside to EPS or FCF estimates, we think the stock is fully valued.

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